The Elbert Files: Two simple rules for success

Two Iowa companies figure prominently in a new Harvard Business Review study that is based on a book, “The Three Rules: How Exceptional Companies Think,” published last week by Portfolio/Penguin.

The authors are Deloitte executives Michael E. Raynor and Mumtaz Ahmed, who quickly confess that there are really only two rules:
1. Better before cheaper – in other words, compete on differentiators other than price.
2. Revenue before cost – that is, prioritize increasing revenue over reducing costs.
The third rule: “There are no other rules – so change everything you must to follow Rules 1 and 2.”

The rules are simple to understand but not so easy to follow, as any experienced executive can testify. They are the result of an exhaustive undertaking that involved collecting and analyzing data on 25,000 companies traded on U.S. stock exchanges between 1966 and 2010.
"The impetus for our research,” the authors wrote in the Harvard study, “was the increasing popularity over the past 30 years of ‘success study’ business books,” including Tom Peters’ “In Search of Excellence” (1982) and Jim Collins’ “Good to Great” (2001). Earlier efforts “don’t give us any way to judge whether companies they hold up as examples are indeed exceptional,” Raynor and Ahmed wrote, because “randomness can crown an average company king for a year, two years, even a decade, before performance returns to mean.”

The new study measured return on assets over decades, identifying successful businesses by long-term profitability. After crunching the numbers, the authors found two traits common to nearly all successful businesses. They were inevitably more interested in quality than price (better before cheaper). They also focused more on the income than the cost side of their balance sheets (revenue before costs). The study’s main example of better-before-cheap is Heartland Express Inc., the North Liberty, Iowa, trucking company founded by Russell Gerdin and operated by his son, Michael, since Russell’s death in 2011.“In 1980, when trucking companies had to differentiate themselves after deregulation,” the study said, “a host of new growth opportunities opened up.” Yet Heartland chose to keep its geographic footprint and number of customers relatively small in order to provide reliable and on-time service, no matter how complex or unpredictable its customers requirements.”

Heartland Express’ superior service attracted and held customers willing to pay a 10 percent premium. Even when the company grew through acquisitions, it succeeded in instilling its corporate culture in new properties, allowing it to continue to collect higher rates for better service.

The study does not mention share prices, but Heartland was among a small group of publicly traded companies whose share price was never appreciably affected by the 2008 recession.

Maytag Corp. is the other Iowa example cited by the authors. The Newton-based manufacturer was acquired by Whirlpool Corp. in 2006, following a steep decline in its final years. For most of its life, Maytag executives followed the two key rules. But then the appliance industry was disrupted by of big-box stores and cheap foreign competition, diverting the focus of top executives.

“Maytag responded by diversifying its product line and price points,” the authors said, causing it to lose the competitive edge that had previously allowed it to charge premium prices and earn solid profits. The authors don’t fault Maytag executives for responding to the threats. It’s the way the executives responded that led to the company’s downfall, they said.

“It takes enormous creativity to remain true to the first two rules,” Raynor and Ahmed said.

The answers aren’t always obvious, they said.

But if you want to be successful, the key can be found within these two rules: Better before cheap and revenue before cost.